Sunday, November 27, 2011

If we are to believe the latest new, France and Germany are now talking about a European fiscal union, widely-held to be what is missing from the failed Euro monetary experiment. It is commonly believed that when a supra-national fiscal body can spend to compensate for private sector losses and/or dissaving in a particular region, this European experiment will be all hunky dory.

But what about labour mobility? Can Greeks or Irish just decide to uproot themselves and start anew in Germany? Can the French do it? Or vise-versa, can Germans just decide to look for jobs in Greece or Portugal? European financial and market integration can increase prosperity in a particular country or sector, while causing social upheaval in another. Inequality arises because while businesses can take their money and technology anywhere in the common area, their workers cannot follow suit, or counter with similar moves of their own. People cannot mitigate the deflationary effects of capital leaving one region by migrating to another, or mute the harsh consequences of a neighbour country’s continual trade surpluses, by piling on to that country.

While countercyclical fiscal policy can help alleviate these deflationary effects, a lack of mobility will still hamper efficient distribution of the benefits of integration. After all, integration probably wasn't pursued merely to allow one country to capture all its commercial value, while another region ends up perennially on welfare, or on make-work programs. There's probably no true union unless all Europeans consider themselves to be Europeans first, who just chose to live in the region they live in. Without freedom of mobility, they're all probably better off having both fiscal and monetary sovereignty.

Thursday, November 17, 2011

I don't normally make book reviews here in the blog, but I recently read Robert Frank's The High-Beta Rich. Now this is not the same Robert Frank who wrote an economics textbook with Ben Bernanke. He's WSJ's wealth reporter who also wrote Richistan: A Journey through the American Wealth Boom. In High-Beta Rich, Frank revisits the lives of some of the people he profiled in Richistan, and follows up on what has happened to them in the years since he wrote the first book in 2006. By 2011, some of these rich people have since gone from riches to rags, or merely to less affluence. He also follows up on some people whose jobs it was to serve the needs of the rich, and profiles how many of them are now finding it hard to secure stable jobs from the rich since the 2008 economic crisis.

The book's central theme is how the rich's fortunes now depend largely on rising asset values, and how asset price movements correspondingly affect their over-all wealth, and so affect their consumption of services, and hence, employment of a lot of people. The book tells stories of formerly rich people, how they came into big wealth during the two decades of continuous rise in debt and asset values, and the rise in conspicuous consumption that came with it. It relates anecdotes of people who bought rich man's toys such as Maseratis, yachts, private jets, and hired private armies of household help, from personal chefs, personal masseuses to household managers a.k.a. butlers. It tells of their experiences finding themselves suddenly back in the world of the non-rich, losing mansions, and then letting go of their butlers .

The book tells of how the rich and their money took over previously more egalitarian towns, such as Aspen, and the rising cost of living that drove away the locals and the economy that thrived on serving those locals, and how in its place arose an economy that simply caters to the whims and demands of the very rich. In one of the chapters, this statement sticks out:

When the waves of high-beta wealth come crashing down, they can affect an entire town like Aspen as well as a much larger canvas like the American consumer economy. In a plutonomy, we're all occasional butlers now, relying in the increasingly erratic jobs and spending of the wealthy.

Frank then elevates the discussion to the state government level and profiles California, which as he shows, has over the years grown more dependent on tax revenues from a few large income tax payers who are largely high-beta rich from Silicon Valley. This sentence stands out:

The masses at the bottom require increased funding for entitlements and social programs. But those at the top, who are increasingly paying for those programs, will exert an outsize influence on politicians through their money and will lobby for lower tax rates. The result is that governments will have more booms and busts and permanent deficits.

I have a problem with one of the author's proposed solutions to the problem of over-dependence on the high-beta rich - that governments, companies, and individuals need to save more during booms so they ride out the busts. This coordinated desire by all sectors of the economy to suddenly save simultaneously is precisely what turns the booms into sudden busts. While the author is referring to local governments, which could literally run out of money, it would have been better if he had made a distinction between a local government, which is merely a currency user, and a sovereign currency-issuing federal government. That sovereign assumes the counter-party role of doing the dissaving whenever the other sectors, the companies and individuals, suddenly stop spending, so as to ensure that the whole economy doesn't suddenly grind to a complete halt.

I would also have appreciated a furthering of this idea:

In the age of high-beta wealth, most of the spending and taxpaying in America will be directed by the stock market. As Greenspan noted, stocks are no longer just measurements of growth and decline, but the main drivers of both. In an economy dominated by the rich, S&P is the new GDP.

While I agree with this statement, I would take it further and say that therein lies the main problem: that S&P is the new GDP, and that people have moved away from the idea of acquiring and maintaing wealth via continuous investment in actual companies, and into getting rich by buying and cashing out at the right time. Nobody plays for the long haul anymore, including those who originally got rich the classic way. Many eventually sell out and use the sudden liquidity speculating in short term investments instead, which while in aggregate results in the self-perpetuating effect of increasing the prices of those very same investments, does not really result in creating new productive endeavours, which is a prerequisite for growing GDP, which is then a prerequisite for the continuous rise in S&P. Without real investments and real growth in the real economy, S&P growth coming from just more money chasing the same investments is not sustainable, and the money being taken out of the real economy will eventually make itself evident with the S&P boom and bust. (Author does profile one guy near the end who gets it).

Nonetheless, if you want a change from reading long serious economic tomes of how and why the economy now experiences more frequent booms and busts, and want to lose yourself in amusing stories of the 'high-beta rich', then this book is worth a read. I found it so when reading my review book.

Saturday, November 12, 2011

I found this statement made by a commenter at another blog several months ago:

"I agree; I think the MMT people are too scathing of what is a simplified explanation of how monetary policy works in normal times. In normal times, starting from an equilibrium in which reserves are held according to their cost and utility, selling more reserves makes it profitable for banks to expand their balance sheets, hence the multiplier, but first the financial crisis and then the payment of interest on reserves altered the balance of their cost and utility. The multiplier collapsed, and it was necessary to add reserves just to serve the existing size of banks’ balance sheets. Moreover when QE involves asset purchases from non-bank counterparties, its initial effect is to expand banks’ balance sheets anyway."

I asked the commenter: What do you mean by “selling more reserves makes it profitable for banks to expand their balance sheets”? I'm guessing this statement indicates you believe that banks lend their deposits to other banks, and that they need to have these reserves first before they can leaned and "expand their balance sheets". So what is the point of the Fed flooding the whole system with reserves then? QE2 in flooding the banks with reserves ensured that no bank will need to borrow reserves anymore, and that no one will need deposits anymore.

MMTers explain that loans are made when there are creditworthy borrowers on hand. Extending a loan (which increases the bank's asset) creates a deposit for the borrower (which creates the offsetting bank liability). Reserves are only later obtained when and if the loan is withdrawn from the bank, or otherwise paid to another bank. Because the bank now has an interest earning loan, it can easily acquire the reserves by borrowing from other banks or attracting new deposits. Central bank intervention via "flooding banks with reserves" does not force banks to make more loans if there are no creditworthy borrowers to be found. If you believe having more reserves is what causes banks to lend, then you probably believe that banks scamper to find depositors first before they allow you to use up your credit card.

I also asked: What do you mean “payment of interest on reserves altered the balance of their cost and utility”? That many bank loans were priced out of the market by the interest on reserves? Is that how low lending rates have gone, that a mere 25 bps IOR discourages banks from making any more loans? Again, this begs the question - why would the Fed "flood the market with reserves" only to borrow them again from the banks with interest?

MMTers explain that the Fed pays IOR to keep the federal funds rate at their policy rate. Otherwise, all that new reserve will be lent on the interbank market at zero, and the fed will completely lose monetary policy control.

And I asked: What do you mean by “it was necessary to add reserves just to serve the existing size of banks’ balance sheets”? What did exchanging Treasuries for reserves “add” to “serve the size of bank balance sheets”?

MMTers explain that QE did not really add reserves net financial assets to banks, and only exchanged their interest-paying risk free government bonds with non-interest-paying bank reserves. In taking away their risk-free interest earning assets, QE ensured that banks start considering retail deposits as profit drains rather than the most cost-efficient source of reserves. Rather than encouraging them to make new loans, it likely discouraged them from accepting more deposits, or accepting them without charging bank fees.

The commenter promised a long blog post explaining his view of the money multiplier and how QE enables this "money multiplier" to function again. After seven months, I'm still waiting.

Saturday, November 5, 2011

Many people continue to hold the false notion that foreign creditors like China are keeping the USD (US currency) value afloat, and that when they stop buying US debt, the value of the USD (US currency) will fall. The reality is that China doesn't need to keep buying US bonds to keep the USD from falling. China buying US bonds is not what keeps USD value up. The Chinese are already locked into buying USD indefinitely, whether they buy its bonds or not, because that’s what they do every time they incur a trade surplus with the US denominated in USD. The dollar keeps strong only if, and this is important, China’s trade surplus is in USD.

Now, the Chinese agree to engage in trade with the US in USD denomination because this allows them to keep their peg with the USD, and no matter how big a surplus they incur with the US, all that influx of USD into their economy will not raise the value of their own currency for as long as the surplus is in USD. That means continuing demand for USD for as long as the peg is in place, and the Chinese wish to maintain their trade surplus. The irony is that, only when the US goes MMT, and prints dollars as needed to fund its trade deficits with China while keeping its own local employment up, will the Chinese see the error of their ways and abandon the peg.

For now, the Chinese continue to maintain the peg despite just getting what to them are useless not-to-be-spent USD in order to maintain their trade surplus, and to keep their own employment up, not out of benevolence to the US. It follows, ironically, that all it takes to arrest the unstoppable increase in US borrowings is for China to accept that the hoard it has accumulated all these years is essentially worthless (because the US can just print more of it to pay them), unless it decides to spend it all back in the US (which means they will start incurring net trade deficits with the US).

If China decides to spend their accumulated dollars domestically in China instead, then that ends their sterilization of the surplus, and effectively ends their peg, and the yuan will then rise vis-a-vis the US dollar. Ending the peg would result in US trade surpluses with China, so there will effectively be less Chinese demand for US treasuries. But the lost demand from China will just be a wash since there will be less need for US borrowings that are due to its deficits with China.

I think China’s main concern, rather than attaining a nice return on its US debt investments, should be that their accumulated dollars do not fall in value vs other currencies. I don’t think they’re too happy with the dollar’s recent fall, which is just as well. They should have spent that money back in the US long ago. That's the only real use for their large accumulation of foreign currency.

China's peg and the current monetary union in Europe are very similar in nature and intent (of those who propagate them). Continued monetary unionhas in effect pegged the core countries' (like Germany's) currency with that of the PIIGS, thereby giving the core the same perpetual trade advantages over the latter that China has with the US. And just like China’s peg to the US dollar, Germany’s currency peg to the PIIGS via the Euro is causing the extensive sovereign borrowings of the latter countries.

This is the reason Europe is now being dragged, German fear of inflation notwithstanding, into the same printing binge as the US dollar. Just look at how the EFSF is supposed to prop up the PIIGS. For how long will this continue before the Germans blink and stop the endless Euro printing? Both the ECB now (and the German banks previously) have continued to pledge buying Greek debt, in order to prop this system up, and to continue with the current status quo. They enjoy continuous trade surpluses with the PIIGS without altering their superior terms of trade, which eventually would happen if each had their own currency. All the Germans need to do to maintain their current terms of trade is to keep the Greeks in a common currency with them. German terms of trade keeps strong only if, and this is important, they keep the common currency with those that currently incur deficits with them. That means continuing Greek demand for the money that Germany ends up with a lot of. So Germany has to ensure that someone keeps buying Greek bonds, to keep their superior terms of trade vis-a-vis the Greeks.

Ironically, all it takes to arrest the unstoppable increase in Greek borrowings is for Germany to accept that the currency hoard it has accumulated all these years is essentially worthless (because the Greeks can't just print more of it to pay them, and will likely default sooner or later), unless Germany decides to spend more of it in Greek products. That's the only real use for their large accumulation of the common currency.

If Germany decides to spend its surplus Euro domestically in Germany instead, then that increases their domestic inflation and ends their superior terms of trade, while the Greek terms of trade rises vis-a-vis theirs. Germans have so far maintained the monetary union despite just getting what to them are useless Greek debt in order to maintain the surplus, and keep their own employment up, and not out of benevolence to the Greeks. The irony is that, only when the EU goes MMT, and prints the Euro as needed to fund trade deficits while keeping Greek employment up, will the Germans see the error of their ways and abandon the peg/common currency.

Search This Blog

"Conventional approaches, unconventional conclusions" on the global finance and economic issues of the day. Rogue Econ has been a banker and financial consultant in several countries. Welcome to my blog.